Brazil’s ‘Cinderella Story’ Gets Sidetracked

A combination of internal turmoil and Fed-driven worries have punished one of the world’s largest emerging markets more than its peers.

Its benchmark stock index, the Ibovespa, is scraping four-year lows and its currency, the real, is at an equally low point against the dollar since that time.

But have the travails created a buying opportunity? Or should investors wait for the dust to settle before deciding to get back into Latin America’s biggest economy?

Stocks

Since Fed Chairman Ben Bernanke first caused investors to fret about the end of QE on May 22, the Ibovespa has fallen 17.1%. By comparison, India and Peru, two emerging markets with high current account deficits and credit ratings hovering above junk status, have each seen their benchmark stock indices fall 7.1% and 8.3%, respectively.

But Brazil’s problems extend beyond the past month. In the past year and a half, U.S.-based emerging market equities funds have averaged $3.5 billion in monthly inflows, according to Thomson Reuters data. U.S.-based Brazilian equities funds, on the other hand, coughed up $179 million on average every month during that period. While the MSCI Emerging Markets index eeked out half a percentage point in gains since Christmas 2011, the Ibovespa has tumbled by 19%.

This fall has put even the biggest emerging markets fans on edge. Win Thin, global head of emerging markets at Brown Brothers Harriman & Co. and a self-described EM bull, said he’s cautioning clients to stay away from Brazil for at least three to six months.

“Loose U.S. monetary policy (and elsewhere in G10, for that matter) was a big factor behind the EM rally,” he wrote in an email. “Now that the easy money is getting less easy, we see outflows from most EM assets over the next couple of quarters.”

IPO

The Brazilian IPO market got off to a record start this year, and looked to be on track to bounce back from a slow 2012. But the slide in Brazilian stocks has cooled the IPO market. In recent weeks, Votorantim Cimentos pulled its IPO, citing poor market conditions, andMoneyBeat reported that Azul has shelved plans for share sales.

Michael Fitzgerald, an IPO specialist and the chair of Latin American practice at law firm Paul Hastings, doesn’t see things bottoming out for a while.

“In Latin America, I’ve given up looking into the crystal ball,” he said. Offering his most educated guess: “I’m talking at least a two-year period.”

Economy

While Brazil is getting caught up in the capital flight from emerging markets, its fundamentals are also contributing heavily to its market declines, evidenced by the looming possibility of an S&P downgrade.

“They’re caught in a perfect storm of probably five bad winds,” Fitzgerald said.

Rafael Dix-Carneiro, an assistant economics professor the University of Maryland, said the country has issues that run deeper than the much-publicized protests over corruption and bus-fare hikes. High inflation, depressed commodity prices and missteps from an interventionist government are weighing down growth, he said.

“Brazil still has serious structural problems, which casts doubt on how it will perform economically in the short to medium run,” he said.

The Upshot

While the market perception of higher interest rates in the U.S. has aggravated the situation, Brazil’s underlying economic problems are also reason for concern.

“The combination of inflation remaining above the central bank’s comfort zone and economic growth projections that were recently revised down has seen dark clouds creeping over Brazilian markets,” wrote Wisdom Tree analyst Rick Harper in a note to investors.

Brazil was once one of the poster childs for the emerging markets, but market activity has changed that view.

“There gets to be a growing sense that the Brazil Cinderella story has gotten sidetracked,” Thin said.